Speaker 1: Hello, and welcome to another episode of the Odd Loots Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe wisn't Paul Joe? Do
Speaker 1: you know what a super lizard is? What a super lizard? No?
Speaker 1: I have no idea, literally none. Do you know what
Speaker 1: a flash lizard is? Nope? A double chat with these?
Speaker 1: Were these animals that you encountered on your vacation? Like
Speaker 1: with these? Like New Year? Did you vacation somewhere exotic
Speaker 1: and see these lizards? I did, well, I was in
Speaker 1: Marrakech and I did see some chameleons. Um. But no,
Speaker 1: this actually has nothing to do with the animals. Uh.
Speaker 1: It has to do with one of my personal favorite
Speaker 1: financial topics. Okay, So what is a super lizard? Super lizard? Uh? Okay,
Speaker 1: So super lizard or flash lizard or a double chance
Speaker 1: or any number of these interesting and exotic type names.
Speaker 1: Is actually a type of structured product known as an
Speaker 1: autocollable or an equity linked security, and these are a
Speaker 1: type of product where investors basically by an interest bearing
Speaker 1: note that's linked to a particular index like the Hang
Speaker 1: Saying or the nick or something like that. Sometimes they're
Speaker 1: also linked to currencies and they basically do it in
Speaker 1: order to make a profit, so they're sort of exotic
Speaker 1: structured products for retail investors, and they come with these
Speaker 1: great names like super or flash Lizard. I am kind
Speaker 1: of aware of these things called structured products. I kind
Speaker 1: of get how they work. But I have to say
Speaker 1: I'm very excited that I'm this is not an episode
Speaker 1: that I'm doing solo, because I have a feeling there's
Speaker 1: going to be one of those ones where I sort
Speaker 1: of sit back and getting a question here and there,
Speaker 1: but mostly I just listened because this is um tough stuff.
Speaker 1: I think, right, it's complicated. I mean literally, just the
Speaker 1: way you're describing it, I get it. I only because
Speaker 1: I've been doing some reading on these I get what
Speaker 1: these notes are. But this is above my head. I
Speaker 1: think you're under selling yourself, Joe. But I mean, the
Speaker 1: reason these structured products are pretty interesting is because you
Speaker 1: see them pop up every once in a while, and
Speaker 1: usually not in a good way. So, for instance, I
Speaker 1: think the most recent example was in you had a
Speaker 1: French bank, Natixis that had a massive blow up because
Speaker 1: it was selling these structured products and had failed to
Speaker 1: hedge them properly or had gotten the hedge wrong. And
Speaker 1: then before that, I don't know if you remember. This
Speaker 1: was when I was in New York and actually sitting
Speaker 1: next to you, But in twenty fifteen, we had a
Speaker 1: big structured product blow up on a type of product
Speaker 1: known as a TARF uh Target Redemption forward I think
Speaker 1: that's called. That was linked to the Chinese un and
Speaker 1: you remember China unexpectedly devalued the u N and it
Speaker 1: caused all sorts of turmoil in these structured products. I
Speaker 1: don't know if you remember, but I think I actually
Speaker 1: wrote a post at Bloomberg at the time that was
Speaker 1: called the TARF BARF. I'm not sure how I got
Speaker 1: away with that. That's a good one. But basically, the
Speaker 1: idea behind these structured notes, and they're sold mostly to
Speaker 1: retail or high net worth investors, is this idea that
Speaker 1: there's some underlying index, like you said, maybe the Hang
Speaker 1: Sang or maybe something in Europe or whatever, and someone
Speaker 1: will pay money. They'll buy one of these notes and
Speaker 1: get some sort of guaranteed return, except if something happens,
Speaker 1: like maybe it goes down too much or whatever. And
Speaker 1: on the flip side, the bank has to buy or
Speaker 1: sell a bunch of derivatives to actually be to deliver
Speaker 1: this guaranteed return. That kind of how it works. Yeah,
Speaker 1: and see, I knew you were under selling yourself before
Speaker 1: I knew you've been because I've been cramming. Okay, But
Speaker 1: the thing I was getting at is the reason they're
Speaker 1: interesting is because they pop up every once in a while,
Speaker 1: and as you mentioned, they're sort of linked to the
Speaker 1: wider financial system because when stuff starts to go wrong
Speaker 1: with them, you do get a wave of what's known
Speaker 1: as delta hedging at the banks, at the issuing banks,
Speaker 1: and that can impact the market itself, and you can
Speaker 1: sort of get a bad spiral. But we're going to
Speaker 1: get into all of those details. We have the perfect
Speaker 1: person to discuss it. I want to bring in, Ben Effort.
Speaker 1: He runs a QVR Advisers, which manages volatility and derivatives
Speaker 1: for big investors. He's also very good on Twitter, so
Speaker 1: you should check them out there. Ben. It's so good
Speaker 1: to have you, Tracy, it's great to be here. Hey, Joe,
Speaker 1: how are you good? How are you doing? Thanks for
Speaker 1: coming up? Not bad about absolutely so. Joe and I
Speaker 1: were trying to sort of lay the scene just then,
Speaker 1: but I think maybe it would be best to start
Speaker 1: with a sort of potted history of how the structured
Speaker 1: products came into being, because the way in which UH
Speaker 1: they initially got sold and the places where they got sold,
Speaker 1: which is mostly in Asia, kind of gives you an
Speaker 1: idea of the underlying dynamics. So give us a short
Speaker 1: summary of how these things came into being. Yeah. Absolutely, So.
Speaker 1: This is an industry that you know here in the
Speaker 1: US and in New York and even in London to
Speaker 1: some extent. You know, you don't think about as much
Speaker 1: unless you're really directly involved, because your average American investor,
Speaker 1: you know, own some stocks and own some bonds, maybe
Speaker 1: own some ETFs around some mutual funds, but doesn't really
Speaker 1: see much of this type of thingum. But when you
Speaker 1: look at more frontier markets, particularly in Asia and and
Speaker 1: earlier in Europe to a large extent, you know, there
Speaker 1: are markets where you're average retail investor or high net
Speaker 1: worth private bank client historically has been very involved in
Speaker 1: in retail structured products sold out of banks. So you know,
Speaker 1: you go go down to your local B and P
Speaker 1: parab wealth manager and UH and he would be helping
Speaker 1: helping suggesting these types of products to retail. So a
Speaker 1: lot of the history. You know, there's there's i think
Speaker 1: myriad reasons for the different development of these products in
Speaker 1: different markets. But in some of the Asian countries is
Speaker 1: a great example where you know, you don't necessarily have
Speaker 1: a long history of traditional equity and bond markets, so
Speaker 1: like in Korea for example, right, but you had a
Speaker 1: very rapid process of wealth creation in the seventies and
Speaker 1: eighties as as these countries industrialized and as you know,
Speaker 1: many middle class rapidly developed and a class of of wealthy,
Speaker 1: wealthy folks, and they were looking for places to put
Speaker 1: their money, and these type of products presented the very
Speaker 1: attractive opportunities that both for banks to sell and in
Speaker 1: some ways for those investors to get involved in. Because
Speaker 1: then we'll get into some of the details. But you know,
Speaker 1: there's many good optics around the investment characteristics of the
Speaker 1: product and also you know typically typically they can be
Speaker 1: you know, currency hedge type of exposures, which matters a lot,
Speaker 1: right as like a local Korean investor, you're not trying
Speaker 1: to get involved in US market someplace and take a
Speaker 1: bunch of currency risks, so you tended to see you know,
Speaker 1: Japan very early developed a big structured products market, was
Speaker 1: one of the first in Asia, and then eventually Korea,
Speaker 1: China also, and you also see a reasonable amount of
Speaker 1: structured products historically coming out of Europe as well, Swiss
Speaker 1: private banks for example. So let's just break this down
Speaker 1: like super vanilla to start, and then we'll get into
Speaker 1: sort of the complicated aspects of why these products are
Speaker 1: interesting in the ramifications, but just in terms so that
Speaker 1: people understand what the buyer of these products are getting.
Speaker 1: So take us through like a very like prototypical I
Speaker 1: don't know, fifty year old person comes in and they
Speaker 1: have some money and they want to make an investment,
Speaker 1: but they're a little worried about risk and volatility, maybe
Speaker 1: they're gonna retire. What is the basic offering that maybe
Speaker 1: someone at the bank is telling this person why it
Speaker 1: may might make sense for them to buy some structured product,
Speaker 1: and what are they sort of being told about the
Speaker 1: upside and the potential risks. Absolutely, So, first I'll give
Speaker 1: you an example of really where the industry got started,
Speaker 1: and then maybe an example from more recent times of
Speaker 1: where the industry has evolved to. So a lot of
Speaker 1: the growth of structured product markets, say in the eighties
Speaker 1: and nineties, of what you would typically see was just
Speaker 1: variations on the good old fashioned principal protected note. So
Speaker 1: this would just be exactly the you know, the person
Speaker 1: who said walks into their local wealth manager and they
Speaker 1: get shown, um, a note that gives them effectively the
Speaker 1: upside price return of the index. Let's call it the eurostock.
Speaker 1: Say it's you know, a Swiss private bank. Um, so
Speaker 1: you know they're going to put a dollars down if
Speaker 1: the eurostocks this goes up, you know, ten percent by
Speaker 1: the maturity of the note. Um, they're gonna get They're
Speaker 1: gonna make ten percent. But importantly, they are going to
Speaker 1: get their principle back no matter what, unless, of course,
Speaker 1: the bank default, which is a whole different story. There's
Speaker 1: some counterparty risk here, but right, So effectively, to the
Speaker 1: end investor, they say, hey, this is great, Right, this
Speaker 1: is kind of like getting involved in the equity market.
Speaker 1: But I'm a little worried that it might go down.
Speaker 1: And from an investor's perspective, it's basically like buying a
Speaker 1: zero coupon bond and a call option. Right, And this
Speaker 1: this worked, right, This was attractive to the investor because
Speaker 1: you've got some downside protection because typically you've got you know,
Speaker 1: reasonable upside. Often investors often don't think about the fact
Speaker 1: that they're getting the price appreciation of the stocks, when
Speaker 1: actually dividends are really important. Right, They're not getting dividends,
Speaker 1: so that's already one way that they're paying for it,
Speaker 1: even if they're not really thinking about it exactly. And
Speaker 1: so often you have those type of aspects where there's
Speaker 1: some slightly subtle trade offs in the economics of the
Speaker 1: note that your typical retail investor might not always think about.
Speaker 1: But hey, they're getting some upside in the equity market,
Speaker 1: they have limited downside, uh, you know, they like you know,
Speaker 1: they like this type of thing. And in the old
Speaker 1: days when interest rates were six percent or eight percent,
Speaker 1: of this worked right because you could buy that zero
Speaker 1: coupon bond effectively, or the bank that's structuring this product
Speaker 1: could fund it by buying a zero coupon bond that
Speaker 1: was going to generate that capital that sort of principal
Speaker 1: protection and then use and then use some money to
Speaker 1: buy a call option. So that's a pretty simple structure,
Speaker 1: pretty easy to understand for the most part. Where now
Speaker 1: that the interesting. You know, a big part of the
Speaker 1: evolution of this market over the last ten years has been,
Speaker 1: so what do you do with this industry when you
Speaker 1: know there's no more sixth rate percent interest rates to
Speaker 1: fund this type of principal protection that was so attractive
Speaker 1: to a certain set of investors. Right these days, you
Speaker 1: think more of the problems or one problem facing investors
Speaker 1: at all types, right is how on earth do you
Speaker 1: generate a decent yield on a on a fixed income
Speaker 1: style investment? Right, You've got you know, if you want
Speaker 1: to get a seven percent yield, and look in the
Speaker 1: credit markets at the quality of credit, you know that
Speaker 1: you have to credit risk that you have to take
Speaker 1: in order to generate a seven percent yield. It's pretty scary. Um.
Speaker 1: And so in this world of very low interest rates,
Speaker 1: effectively what structured products businesses at banks that manufacture these
Speaker 1: products andthink creatively about, you know, what they can offer.
Speaker 1: They found various ways to effectively sell options to generate yield,
Speaker 1: right in a world with low interest rates on the
Speaker 1: way that you generate yield for the most part, as
Speaker 1: you set you either take credit risk or you sell options.
Speaker 1: And so a more typical type of product these days.
Speaker 1: That has grown very rapidly over the last ten years.
Speaker 1: Tracy alluded to it is what you might call the
Speaker 1: reverse convertible auto call, and and what that of those
Speaker 1: products effectively are a zillion different variations on a very
Speaker 1: simple idea, which is, you know, the investor is going
Speaker 1: to put down their hundred dollars, they're going to get
Speaker 1: a coupon, an annual coupon, just like a bomb, so
Speaker 1: call it six percent or eight percent, but in exchange,
Speaker 1: they're going to take the risk that if something bad happens,
Speaker 1: they're going to lose a bunch of money. Typically it
Speaker 1: would be if the underlying index or the worst return
Speaker 1: within a set of underlying in disease was down, say,
Speaker 1: or thirty five percent at any points in the next
Speaker 1: few years, they're just going to lose that get knocked
Speaker 1: out of that note, and lose their So effectively, they're
Speaker 1: they're selling that option to the to the to the
Speaker 1: bank in exchange for getting that coupon, and then they'll
Speaker 1: come with all kinds of other bells and whistles on them.
Speaker 1: But that's the very basic idea, is you get a
Speaker 1: coupon a fixed income stream in exchange, you take that
Speaker 1: risk of the of the bad scenario. So, Ben, you
Speaker 1: mentioned the issuers behind these products, which are are usually banks,
Speaker 1: often French ones. Oddly enough, walk us through exactly how
Speaker 1: the banks sell these products and where their profits come from.
Speaker 1: When they're selling this sort of panoply of offerings you know, autocollables,
Speaker 1: equity link securities, tarts, whatever you want to call them.
Speaker 1: Absolutely so, there will typically be you know, several layers
Speaker 1: of of the of the value chain and distribution. Right, So,
Speaker 1: the clients, the end retail investor will be sitting down
Speaker 1: with a broker or with a financial advisor of some kind,
Speaker 1: right and typically um, when the client buys that note,
Speaker 1: typically there's first some kind of commission directly to the
Speaker 1: financial advisor, right. Um. Then often there will also be
Speaker 1: just an upfront load, the same way you used to
Speaker 1: see upfront loads on mutual funds. So there might also
Speaker 1: be an upfront effectively commission that goes back to the bank.
Speaker 1: Then within the bank, there's probably a structuring you know,
Speaker 1: structuring desk that was involved in the creation of the
Speaker 1: security that might get that might get a cut. There's
Speaker 1: the trading desk itself, which have is going to make
Speaker 1: a price for that note. So typically the note will
Speaker 1: be structured and it will be offered, and the trading
Speaker 1: desk will will make a price, and typically that price
Speaker 1: will contain effectively some bit ask spread, the same way
Speaker 1: that any trade that one was to quote a bank
Speaker 1: on would contain some bit ask spread. You know, most
Speaker 1: of these different pieces. You know, usually the upfront charge
Speaker 1: on the security is transparent to the end investor. You know,
Speaker 1: the commission to the to the broker typically would not
Speaker 1: be certainly the bid ask spread to the traders sort of,
Speaker 1: whereas the fair value of this note would not be
Speaker 1: transparent to the investor. So you know, usually there's quite
Speaker 1: a lot of embedded costs and these, you know, and
Speaker 1: only only part of it would typically be transparent to
Speaker 1: the end client. So one of the benefits to the
Speaker 1: banks who are issuing the products is that they get
Speaker 1: all these fees and commissions as you describe, and they
Speaker 1: also sort of get a cheap form of funding via
Speaker 1: the retail investment. But it doesn't come for free for
Speaker 1: the banks in the sense that they actually have to
Speaker 1: offset the exposure that they're taking on by selling the products.
Speaker 1: And this is where I promise autocollables and equity link
Speaker 1: securities start to get really interesting. It's actually through the
Speaker 1: relationship with the issuing bank. So how exactly do the
Speaker 1: issuers go about hedging their exposure. Yeah, no, that's exactly right, Tracy.
Speaker 1: So banks are not in the business of taking market
Speaker 1: risk on the other side of these type of transactions, right,
Speaker 1: the bank ideally wants to generate the set of fees
Speaker 1: for the service that it's providing to the to the
Speaker 1: end investor, and then to isolate that and to hedge
Speaker 1: out the market risk. Right, So the bank is issuing
Speaker 1: a liability effectively right where it's promising to pay the
Speaker 1: end investor according to the terms of the note. In
Speaker 1: the case of you know, the old fashioned, very simple
Speaker 1: thing that I described, that principle protected note, if it's
Speaker 1: a very vanilla one, let's say you know, a eurostocks
Speaker 1: effectively call option plus embedded embedded bond, that's quite simple
Speaker 1: to hedge. Right, the bank might issue this principle protected note.
Speaker 1: It might buy some buy some zero coupon bonds, and
Speaker 1: it might buy some call options on the eurostocks, and
Speaker 1: that might actually be you know, quite at quite a
Speaker 1: good hedge. Right in the case of reverse auto call
Speaker 1: type of securities where the client is actually selling options
Speaker 1: to the bank. In this case, typically the bank is
Speaker 1: having to go out and sell downside puts, typically longer term,
Speaker 1: in order to be a first order of magnitude hedge
Speaker 1: for these type of securities. The trick really comes in
Speaker 1: and how complex these notes get quite quickly, right, so
Speaker 1: you know that the simple example is again just take
Speaker 1: the eurostocks again. Maybe the client puts down a hundred
Speaker 1: dollars and it's going to get eight percent coupon unless
Speaker 1: the Euro stocks is down at some point upon which
Speaker 1: they get knocked in. One subtlety there the description of
Speaker 1: that short optionality. That's not just being short of put option, right,
Speaker 1: it's being short something trickier because the client doesn't actually
Speaker 1: lose money unlesson until the eurostocks is down and then
Speaker 1: they lose, right, So that's actually something that's called a
Speaker 1: knock in put option, and right away that's like a
Speaker 1: tricky thing that doesn't have any easy replicating portfolio and options.
Speaker 1: And then as implied volatilities fell and yields fell, banks
Speaker 1: had to add more and more features to these notes
Speaker 1: to make them still generate that six or seven or
Speaker 1: eight percent yield that the clients wanted right. So typically
Speaker 1: these days you'll see that type of product. It won't
Speaker 1: just be linked to the eurostocks. It will be linked
Speaker 1: to the eurostocks and the H S C E I
Speaker 1: and the Knik for example, and it will act as
Speaker 1: if whatever the worst performing index of that whole basket
Speaker 1: is right. So that introduces a bunch of very hard
Speaker 1: to manage risk from the perspective of a bank. So
Speaker 1: you know, typically if you talk to to anybody who
Speaker 1: runs one of these these portfolios managing these risks, you
Speaker 1: know they'll they have very complex models and at the
Speaker 1: end of the day they'll describe their risk as sort
Speaker 1: of a reasonable guess. So before we go on, there's
Speaker 1: a couple key points of clarification that I just want
Speaker 1: to wrap my head around in terms of how these
Speaker 1: things work. So the first question that I have, can
Speaker 1: you explain for people and maybe including me, who don't
Speaker 1: totally understand it when you say they have to sell
Speaker 1: options to generate yield. Just this basic concept is the
Speaker 1: idea essentially that that you're selling downside protection. You're selling
Speaker 1: puts to people who are sort of natural hedgers or
Speaker 1: people who want to buy downside protection, they pay for
Speaker 1: that downside protection, and that becomes the de facto yield
Speaker 1: or that becomes a de facto yield for the line.
Speaker 1: Does that essentially what you're saying, Yeah, exactly. So when
Speaker 1: you sell an option, you receive a premium for doing so. Right,
Speaker 1: So if you go out into the market and you
Speaker 1: sell us three year, you know, out of the money
Speaker 1: put on the euro stocks, you're going to get paid
Speaker 1: um some amount of euros for that. And if and
Speaker 1: that you know that it will have a price that
Speaker 1: will fluctuate. But if you go throughout the life of
Speaker 1: that three year option and expires worthless, you will have
Speaker 1: collected that premium over that period of time, and you
Speaker 1: can think of that as a yield. And then you
Speaker 1: mentioned there's like this weird situation where Okay, let's say
Speaker 1: the owner of the note is knocked in if the
Speaker 1: if the underlying index against which the note is written
Speaker 1: save if it falls, then that person loses. But if
Speaker 1: it only falls, or if it only folvescent, then the
Speaker 1: bank is compelled to make the note hold our whole.
Speaker 1: So what you're describing in terms of the complexity and
Speaker 1: the difficulty of like finding this perfect hedge is as
Speaker 1: a result of this fact that the risk builds for
Speaker 1: the bank as the market falls and falls until a
Speaker 1: certain point, and then the risk kind of disappears and reverses,
Speaker 1: which makes I guess this particularly tricky and finding the
Speaker 1: right valuation and price for these things. That's right. This
Speaker 1: is a it's a type of barrier option. It's a
Speaker 1: very complex security, right, which is quite hard to hedge
Speaker 1: exactly as you point out, as the market as the
Speaker 1: underlying index approaches that barrier point for one particular note,
Speaker 1: you have sort of a binary a binary result. Right
Speaker 1: either if it if the market goes down a bunch more,
Speaker 1: you're going to trigger and the underlying note is going
Speaker 1: to cost the underlying investor a bunch of money. But
Speaker 1: if it doesn't, if it just stays there, then it's
Speaker 1: actually then that that risk fades away. And in a
Speaker 1: in a complex portfolio of many and many many of
Speaker 1: these kinds of notes with all different linkages to different indicries,
Speaker 1: you know, the hedge is quite difficult to the initial
Speaker 1: Tipically that banks will will do an initial proxy hedge,
Speaker 1: which for most of these types of instruments when they
Speaker 1: issue new structured product risk they'll be out in the
Speaker 1: market selling you know, longer term call it two or
Speaker 1: three year, twenty or thirty percent out of the money
Speaker 1: put options you know, which aren't okay day one proxy
Speaker 1: hedge for the style overall flavor of the risk you know.
Speaker 1: But over time, as these products age and different indicries
Speaker 1: go up or other ones go down, and all of
Speaker 1: the risk you know, moves moves all over the place.
Speaker 1: But then all the you know, the really fun stuff
Speaker 1: and you you alluded to this is really in you know,
Speaker 1: the at this point, these are very large markets, right,
Speaker 1: so we're talking about you know, Korea alone is well
Speaker 1: over a hundred billion dollars a year of issuance of
Speaker 1: these type of products. Japan is large, you know, some
Speaker 1: some European locations are decent sized. And these these the
Speaker 1: risk from these products are actually sort of the largest
Speaker 1: sources of buying and selling of longer term options on
Speaker 1: global indusries in the world, right, so bigger than like
Speaker 1: pension funds doing hedging, for example, or bigger than hedge
Speaker 1: funds buying or selling long term in disease. And so
Speaker 1: what that means is the when you get so that
Speaker 1: the banks that are out in the market having to
Speaker 1: manage this risk. You know, typically are all in a
Speaker 1: similar type of position, right, because more or less the
Speaker 1: products that they're selling to retail have the same characteristics,
Speaker 1: and when something funny happens, they are a huge part
Speaker 1: of the volume of that market and all trying to
Speaker 1: do the same thing. So Tracy alluded to, for example,
Speaker 1: you know, what you had was this the scenario in
Speaker 1: which Chinese markets rallied very very fast in the summer,
Speaker 1: and there was a lot of issuance of these types
Speaker 1: of products as retail was very involved in speculation and
Speaker 1: equity markets. And then the market suddenly fell over a
Speaker 1: few months almost in China, right, the equity markets, and
Speaker 1: what that meant was many of these products, right, So
Speaker 1: banks had been gone out and sold downside put options
Speaker 1: and sometimes very and swaps against these portfolios of auto calls.
Speaker 1: But then as the market falls very fast, all of
Speaker 1: a sudden, the auto calls start, you get close to
Speaker 1: knocking out some of them knock out, and the banks
Speaker 1: all have to go and buy back those hedges which
Speaker 1: they've sold, right, because they run into this this barrier
Speaker 1: problem where they have this kind of complex security that
Speaker 1: they had an okay, hedge four day one. But once
Speaker 1: you have a big market crash all of a sudden,
Speaker 1: that's not a good hedge anymore. And you had a
Speaker 1: huge short squeeze and options and volatility that blew up
Speaker 1: a bunch of banks and a bunch of hedge funds.
Speaker 1: Some hedge funds made a bunch of money and some
Speaker 1: hedge funds lost a bunch of money, and it was
Speaker 1: causing a very major issues in those markets. So they
Speaker 1: kind of all end up I guess short vall when
Speaker 1: these things get knocked in, which means they have to
Speaker 1: buy more puts and some more features and sort of
Speaker 1: do this imperfect hedge at exactly the wrong time, and
Speaker 1: they have to compete with everyone else to do the
Speaker 1: imperfect hedge at exactly the wrong time. Exactly, No, that's
Speaker 1: exactly right. So the key thing to think about is
Speaker 1: the banks when they do these, when they issue these
Speaker 1: types of securities, they're effectively buying, you know, downside puts
Speaker 1: of a complicated form from investors, and they're heading them
Speaker 1: by by selling relatively simple vanilla puts typically because those
Speaker 1: are the things that you can hedge with, and the
Speaker 1: mismatch between the two really arises when markets are selling
Speaker 1: off very quickly, right when the the that risk that
Speaker 1: with that when that volatility, when that downside protection that
Speaker 1: the banks have effectively bought from retail investors starts to
Speaker 1: go away because you start to get down close to
Speaker 1: those knockout barriers, you know, the probability of those notes
Speaker 1: starting to knock out rises very fast, and all of
Speaker 1: the sudden, banks are left you know, short, a bunch
Speaker 1: of options that they've sold the hedge, but they're but
Speaker 1: their long option position, their protection is starting to go away,
Speaker 1: and it's all happening to all the banks all at
Speaker 1: the same time. So, just regarding the hedge, one thing
Speaker 1: I've always wondered is, you know, you said that the banks,
Speaker 1: the issuers make most of their money through commissions and
Speaker 1: fees on on these products, and I get that they
Speaker 1: want their exposure to be relatively neutral um for what
Speaker 1: they're selling, But is there any um is there any
Speaker 1: motive by the banks to also generate profit through the
Speaker 1: hedge itself, Like, is there a way to creatively hedge
Speaker 1: in such a way that you can juice your returns
Speaker 1: a little bit or add a little bit of extra revenue.
Speaker 1: There is usually there are many such ways to do so.
Speaker 1: Usually they involve taking more basis risk than you should
Speaker 1: and by sort of taking some hidden risks. Right. So
Speaker 1: that's of course one of the common themes of derivative
Speaker 1: markets in general is usually the easiest way to juice
Speaker 1: your returns and make your boss happiest to take some
Speaker 1: hidden risk um that will occasionally flare up and blow
Speaker 1: you up. Right. So was a great example of that
Speaker 1: in China um several of the banks much of their
Speaker 1: hedge portfolios against structured products linked to Chinese equity markets
Speaker 1: were in the form of variant swaps rather than options.
Speaker 1: I think of variances is the square of volatility, right,
Speaker 1: So the main difference between a variant swap and a
Speaker 1: portfolio of options is just that when things get really bad,
Speaker 1: you're you know, you lose money with a squared term
Speaker 1: sort of on the in the size of the amount
Speaker 1: of money that you lose, which is generally very bad.
Speaker 1: But in normal markets you get paid if your short them,
Speaker 1: you get paid a little bit of extra money for that, right,
Speaker 1: And so as a result, so variant swaps have the
Speaker 1: opposite profile of of the support underlying portfolios of auto
Speaker 1: calls in the sense that the auto calls as the
Speaker 1: market goes down and down and down. Actually, eventually the
Speaker 1: volatility protection from those auto calls from the bank's perspective
Speaker 1: goes away, right because you start to knock out or
Speaker 1: you get very close to knocking out, whereas varian swaps
Speaker 1: are the opposite, where the worst things get the more
Speaker 1: exposure of varian swapads. So there were several banks that
Speaker 1: had very heavy exposure to variance swaps on the short
Speaker 1: side as their heads in order to duce their returns.
Speaker 1: As you said, that made their their profits look pretty
Speaker 1: good for for several years, but then caused massive and
Speaker 1: outsized losses in Q three when when the equity markets
Speaker 1: found so um you know, quick answer, yes, absolutely, there's
Speaker 1: ways to to to generate additional revenue in those portfolios
Speaker 1: by by taking some extra mismatch risk, by effectively being short.
Speaker 1: Extra tail risk generally generally comes around to bite you. Okay,
Speaker 1: I need to back up for a second and understand
Speaker 1: the risk that the bank is exposed to when the
Speaker 1: retail holder of the note is knocked in. So again,
Speaker 1: we have these notes that protect the investor from any
Speaker 1: downside risk until say one index or maybe one of
Speaker 1: multiple index strap. So then let's say that happens, and
Speaker 1: then the retail investor no longer has any protection. They're
Speaker 1: down on their initial capital. Why is that bad for
Speaker 1: the bank? Why does that create a mismatch? Then that
Speaker 1: require yours some sort of aggressive you know, as you
Speaker 1: put it, a short squeeze in the options. Sure, absolutely so.
Speaker 1: So let's go with our simple example. So we've got
Speaker 1: a retail investor that bought a hundred dollars of this
Speaker 1: of this auto call that's effectively going to give them
Speaker 1: a yield unless the underlying indexes down, upon which the
Speaker 1: no will just go away and they'll lose. Right, So
Speaker 1: that in of itself from the bank's perspective, of course,
Speaker 1: if the if the note, if the market is down
Speaker 1: and and we trigger the knock out, what that's just
Speaker 1: going to mean is the bank is not going is
Speaker 1: going to have to only pay you seventy cents back
Speaker 1: instead of a hundred or a hundred dollars back. And
Speaker 1: they just did theory the bank would prefer at decline
Speaker 1: to decline, right? Or does that yes, except the bank
Speaker 1: has headed this product, right, But the bank doesn't just
Speaker 1: sell all these right, because otherwise than the bank just
Speaker 1: has massive directional exposure to everything. Right, So the bank
Speaker 1: has headed this note, and the bank has sold a
Speaker 1: bunch of out of the money three year put options
Speaker 1: on the on the underlying index, right, and so as
Speaker 1: with the market starts to go down and down and down.
Speaker 1: Actually the typically the dynamics of this from a hedging perspective,
Speaker 1: the bank will get a little bit longer volatility at first,
Speaker 1: and that just has to do with the fact that
Speaker 1: of the structuring of this knock and put options, so
Speaker 1: often the bank will actually have to sell a little
Speaker 1: bit more of those put options, you know, for the
Speaker 1: first of the market decline. But once we get in
Speaker 1: to your point, once then the market goes down and
Speaker 1: down and down, and nearing this knockout point, right, the
Speaker 1: bank is still short all of those put options that
Speaker 1: it's sold, right, And the only thing that's going to happen,
Speaker 1: And once that note knocks out, then the bank pays
Speaker 1: the investor seven you know, the seventy dollars having you know,
Speaker 1: taken in a hundred dollars first, that's fine, but they
Speaker 1: still have all of these Now they've just outright short
Speaker 1: a whole bunch of put options right, and they've got
Speaker 1: to go buy those back because they have no hedge
Speaker 1: for them. And of course all of this in option
Speaker 1: land is is sort of forward looking and probabilistic, right,
Speaker 1: So as the market goes down and it starts to
Speaker 1: look like you're getting close to knockout, then banks are
Speaker 1: getting worried and they're they're starting to effectively get short
Speaker 1: volatility in the in the portfolio because the notes are
Speaker 1: losing some volatility exposure as it looks like they might
Speaker 1: knock out with with higher and higher probability. And that's
Speaker 1: this kind of dynamic where all of a sudden, the
Speaker 1: banks starts scrambling to cover those hedges. So this is
Speaker 1: one avenue essentially where markets can really impact the financial
Speaker 1: health of banks um and banks can also impact the
Speaker 1: markets as well. And I think there was actually a
Speaker 1: moment in time where if you looked at the Hang
Speaker 1: Sang index, it was kind of tracking against the index
Speaker 1: of Korean brokerages and and Korean banks, and you could
Speaker 1: sort of see that link very very clearly. So my
Speaker 1: question is, in a long and convoluted way, why aren't
Speaker 1: regulators more focused on this because it seems like a
Speaker 1: pretty obvious and potentially troublesome source of of a feedback loop. Basically, yeah, absolutely, so,
Speaker 1: you know, Korean regulators have paid attention to this over
Speaker 1: the years. UM. They typically have come in usually after
Speaker 1: a blow up UM. Korean banks did lose quite a
Speaker 1: lot of money in twenty banks and brokerages after the
Speaker 1: China debacle UM, and and the regulators will come in
Speaker 1: so they restricted, for example, they restricted the percentage of
Speaker 1: of new issuance of structure products that could be linked
Speaker 1: to Chinese indices after that meltdown in UM. But typically
Speaker 1: they've taken a relatively las fair approach to this space.
Speaker 1: They've looked at you know, basic investor protection, you know,
Speaker 1: whether the disclosures are adequate and so forth. UM. But
Speaker 1: you know, globally there just hasn't been that much focused
Speaker 1: on it. I think, you know, regulators have a lot
Speaker 1: of different things to look at and have to make
Speaker 1: decisions about what they're what they where they think the
Speaker 1: biggest risks are, and what they think, you know, where
Speaker 1: they think systemic risk is. Historically, it hasn't been a
Speaker 1: space that they that they focused on a tremendous amount. Again,
Speaker 1: outside of Korea, to some extent because this is so like,
Speaker 1: these these products are so large relative to the Korean market,
Speaker 1: and when Korean banks get involved, you know, they can
Speaker 1: be um huge drivers of of Korean banks. Uh, you
Speaker 1: know solvency. So something that you mentioned, you said in
Speaker 1: some hedge funds lost out of money, some hedge funds
Speaker 1: made a lot of money. How does an outside player
Speaker 1: who's attempting to take advantage of the potential for some
Speaker 1: sort of extreme moves in the options market as certain
Speaker 1: barriers get hit or they think this is a risk
Speaker 1: out there and they want to be in a position
Speaker 1: to exploit it, how do they get a handle on
Speaker 1: where the various knock in levels are. Given that there's
Speaker 1: a range of different notes with different underlying indicries, all
Speaker 1: sold at different times in different days, and I'm sure
Speaker 1: every day the reprice and reset and all that, how
Speaker 1: does one start to get a handle on where these
Speaker 1: sort of key levels of risks lie and therefore when
Speaker 1: one might expect to see a short squeeze in a
Speaker 1: particular flavor of options. Yeah, absolutely, so that that's that's
Speaker 1: exactly the right question. I think so. Uh, these days,
Speaker 1: much of the of the issuance of these products is
Speaker 1: publicly observable, and what you see is is banks and
Speaker 1: research desks at banks, you know, building up data sets
Speaker 1: and models of all of these types of exposures. So typically, um,
Speaker 1: if you know you're involved in the space, you know
Speaker 1: you're you're you have coverage from the various French banks
Speaker 1: that are very heavily involved, and they will typically have
Speaker 1: a set of models that that try to estimate. All right,
Speaker 1: here's all the different indices that all these notes are
Speaker 1: linked to. Here's what banks risk profiles look like here,
Speaker 1: and you'll and what the typically very interesting questions is,
Speaker 1: you know, how much volatility exposure do these portfolios of
Speaker 1: auto calls the banks hold have as a function of
Speaker 1: where as at the level of the indices, right, So,
Speaker 1: so I mentioned typically those risks grow to some extent
Speaker 1: as equity markets start to go down, and then the
Speaker 1: key question is where do they stop growing and then
Speaker 1: where do they suddenly fall off a cliff as you
Speaker 1: really start to get into and go through that that
Speaker 1: knockout zone. And so for example, you know these days
Speaker 1: in the SMP, you know right now there might be
Speaker 1: out of out of Korea and Japan, there's probably you know,
Speaker 1: a hundred million dollars of exposure to one point one
Speaker 1: point change in volatility. So think of like the vix
Speaker 1: as you know, fifteen that's in volatility points. So a
Speaker 1: hundred million VEGA means if that goes up by one point,
Speaker 1: the profits or losses associated with that as a hundred
Speaker 1: million dollars, So that that number goes up about any
Speaker 1: percent as the mark as the SMP goes down to.
Speaker 1: But then it starts to really follow up the cliff
Speaker 1: very fast and buy about you know, two thousand or
Speaker 1: eighteen hundred. It's going away quite quickly. And so that's
Speaker 1: but in those types of of estimates are modeled and
Speaker 1: something that you can keep track of pretty well. And
Speaker 1: you know, the the interesting question you know, partly to
Speaker 1: hedge funds, but I think largely to tow larger institutional
Speaker 1: investors and asset owners. You know, usually when you're out
Speaker 1: there looking for hedges, are looking for long term um
Speaker 1: portfolio protection. The key question is always you know, what
Speaker 1: is supply and demand. Are you trying to buy expensive
Speaker 1: you know, risk protection that somebody else that everybody else
Speaker 1: is trying to buy two or is there really a
Speaker 1: supply of it in the marketplace. Is there a big
Speaker 1: source of selling of the of the risk that you're
Speaker 1: trying to get ahold of. And this is a good
Speaker 1: example of you know, retail investors instructure products being a
Speaker 1: large source of selling of of long term tail risk
Speaker 1: in major equity indicries. And so folks will folk us
Speaker 1: very heavily on you know, the as an asset owner,
Speaker 1: as a pension fund. You know, what's what's my risk
Speaker 1: profile for my organization as a function of of equity markets?
Speaker 1: You know, of my equity exposure. You know where do
Speaker 1: I start to get as an organization into major distress costs?
Speaker 1: How does that map into UM? What kinds of protection
Speaker 1: I might get from UM from these types of from
Speaker 1: from options in this type of range, given that, uh,
Speaker 1: you know the banks, you know where the equity market
Speaker 1: will be in my in my bad scenarios and whether
Speaker 1: there's going to be you know, big squeeze and the
Speaker 1: prices of those options. It's the kind of thing people
Speaker 1: think about. So, Ben, you mentioned the S and P
Speaker 1: five hundred just then in your example, and this is
Speaker 1: where we start to get into some of the newer
Speaker 1: developments in structured product land and something new that is
Speaker 1: happening is that we're seeing more of these that are
Speaker 1: actually pegged to US indices as opposed to sometimes obscure
Speaker 1: Asian equity markets. Why is that happening and what does
Speaker 1: it actually mean for the wider market? That's right, So
Speaker 1: this has been a very very interesting trend the last
Speaker 1: few years. So, first of all, to your point, there
Speaker 1: has been more and more of this underlying issue and
Speaker 1: directly linked to the SMP. Part of the reason for
Speaker 1: that is that implied the option prices and implied volatilities
Speaker 1: on some of those international industries have come down and
Speaker 1: down and down over the last few years, partly driven
Speaker 1: by by the selling of of these types of products
Speaker 1: and and also partly driven by the fact that actually
Speaker 1: realized volatility globally has been falling, and you've had a lot. Actually,
Speaker 1: most of the volatility episodes and equity markets over the
Speaker 1: last couple of years have been US centric and SMP centric.
Speaker 1: So I think of like the February you know of
Speaker 1: all blow up and December, right, these were really US
Speaker 1: centric events, and so unusually from a historical perspective, actually
Speaker 1: SMP volatility and option prices have been relatively higher and
Speaker 1: relatively for were compared to international, which of course attracts
Speaker 1: you know, mixing S and P and for for to
Speaker 1: sell options to generate those higher coupons that the retail
Speaker 1: investor wants. Now, the other really important thing that's been
Speaker 1: happening here again, you know, think of of banks as
Speaker 1: the manufacturers of this of this industry, of this risk
Speaker 1: right where they're generating this fixed refew revenue and then
Speaker 1: the price that they're effectively paying for it is the
Speaker 1: risk that they're taking to manage these portfolios. The you know,
Speaker 1: as we saw in particular, you know there's a lot
Speaker 1: of it's quite difficult to manage this risk in general,
Speaker 1: but especially in you know, Chinese equity markets, in Japanese
Speaker 1: equity markets. You know, these are smaller option indus cries
Speaker 1: that don't have as big a volumes where where these
Speaker 1: markets the structured products really really dominate the risk in
Speaker 1: these markets and where the liquidity issues are very exacerbated.
Speaker 1: So one thing banks really started to look at in
Speaker 1: earnest over this period was, you know, how can we
Speaker 1: get more of this risk into an easy year to
Speaker 1: manage format where we're not having to frantically sell more
Speaker 1: options as markets go down for a little while and
Speaker 1: then frantically buy a whole bunch of them back in
Speaker 1: you know, China, where it's really hard to do this.
Speaker 1: So what they started to do was create relatively complicated
Speaker 1: investment products for hedge funds, called, for example, cord or
Speaker 1: variant spread, which had the end goal and an effective
Speaker 1: purpose of basically moving a bunch of this risk that
Speaker 1: they had to manufacture out of those smaller indicries globally
Speaker 1: and into the SMP, which is the world's biggest, most
Speaker 1: liquid option market. And they do that in various, you know,
Speaker 1: complicated ways that we don't need to get into. But
Speaker 1: the the end effect is that even though they've issued
Speaker 1: a lot of notes that are directly linked to the eurostocks,
Speaker 1: to the NIQUE, to the h c I, when global
Speaker 1: equity markets go down, banks find most of the changes
Speaker 1: in their risk profile which they need to go out
Speaker 1: and manage and hedge at least to first order, They
Speaker 1: find those changes happening in the SMP, and they that
Speaker 1: might be that initially again for that first as the
Speaker 1: markets start to drift down, they're having to sell some
Speaker 1: downside SMP options, but then they're going out and having
Speaker 1: to buy the SMP options that if the if the
Speaker 1: market crashes. So that's a very new over the last
Speaker 1: few years. So just to be clear, is it that
Speaker 1: the note in the basket of the indicries that it's
Speaker 1: exposed to, is it that it has the sp it
Speaker 1: or is it simply a mix of that? Plus also
Speaker 1: the idea that even if the note is exposed to
Speaker 1: the hang sing or something like that, that the bank
Speaker 1: might find it still most expedient to hedge via SMP
Speaker 1: options on the premise that on some level there's a
Speaker 1: level of correlation and even if it's not the perfect
Speaker 1: hedge for them, that that might be the place to uh,
Speaker 1: the cheapest, most liquid place to hedge their risk. So
Speaker 1: there has been some increasing direct link of these notes
Speaker 1: to the SMP, but it's still a minority. It's still
Speaker 1: going to be them or something like that. The and
Speaker 1: they they're not typically just warehousing tons of basis risk
Speaker 1: and only hedging an SMP. But what they're doing again
Speaker 1: is is so i'll you know, explain a little bit
Speaker 1: what a what a corridor variant spread it. So let's
Speaker 1: say the bank has this auto call that it's you know,
Speaker 1: sold to Bob and so the bank has that risk
Speaker 1: profile that we've been talking about it. You know, it's
Speaker 1: a proxy hedge for that was going out and selling
Speaker 1: some downside puts on the eurostocks. But the bank's going
Speaker 1: to go into another trade with a hedge fund, and
Speaker 1: that trade is going to be something like, hey, here's
Speaker 1: this volatility exposure, which is going to be a spread
Speaker 1: between the eurostocks and the SMP, and that's that exposure
Speaker 1: is going to be conditional on the strike level, on
Speaker 1: the level of the index in a way that kind
Speaker 1: of roughly matches what they think the profile, you know,
Speaker 1: of those auto calls is. And what that does is
Speaker 1: now the hedge fund is going to have that the
Speaker 1: hedge fund is going to hold that weird, difficult to manage, uh,
Speaker 1: you know risk in the eurostocks, and the bank is
Speaker 1: going to have the same the similar type of risk,
Speaker 1: but they're going to have it in the SMP on
Speaker 1: a net basis. Once you're combining that trade they just
Speaker 1: did with a hedge fund and the and the auto
Speaker 1: call that they that they've sold to to retail, and
Speaker 1: you know, you're adding layers and layers of complexity because
Speaker 1: now you've got, you know, a complicated product you've sold
Speaker 1: to retail that you've kind of tried to hedge by
Speaker 1: selling doing another complicated trade with a hedge fund. And
Speaker 1: so there's you know, all sorts of more just weird
Speaker 1: bad path scenarios where you know, things go funny. But
Speaker 1: the first order, the first order result is that the
Speaker 1: banks that all those changes in volatility risk that happen
Speaker 1: at banks as a result of global markets moving down,
Speaker 1: they all happen to first order in the SMP now,
Speaker 1: a little bit in other industries tube and much more
Speaker 1: now in the SMP. And so that's really really important.
Speaker 1: This is something we've never really seen before where you know,
Speaker 1: it used to be markets that you know, typical S
Speaker 1: centric investors and pension funds and real money guys didn't
Speaker 1: notice as much, you know what's happening, and you know
Speaker 1: in the HSCI option markets. But now those dynamics are
Speaker 1: all being translated into the S and P and for example,
Speaker 1: you know what we saw in December of last year.
Speaker 1: You remember, markets peaked to trough, were down or so
Speaker 1: by by Christmas eve, and everybody sitting on structured products
Speaker 1: desks was sitting there staring at their risk profile and
Speaker 1: thinking if the market goes down another five percent, like
Speaker 1: we're just completely screwed, because you that was where you
Speaker 1: were starting to get into much of this non linearity
Speaker 1: where all of a sudden, all their risks, but their
Speaker 1: long volatility exposure, their protection coming from those auto calls
Speaker 1: was starting to disappear very fast. And instead we got
Speaker 1: that six percent rally the next day and shot off
Speaker 1: from there. But we were actually very close to a
Speaker 1: very very major loss event, you know, across potentially across
Speaker 1: the street, and that could have cascaded into all sorts
Speaker 1: of of crowded hedge fund positioning as well. And that's
Speaker 1: just something that's not on I think acid owners ratear
Speaker 1: screens at all. The fact that this you've had this
Speaker 1: kind of infection of typically very historically much more normally
Speaker 1: behaving markets that used to be the places where pension
Speaker 1: funds went to hedge or you know what have you,
Speaker 1: that are now being very dominated by these weird, complicated
Speaker 1: structured product dynamics is the implication that we might not
Speaker 1: be as lucky next time. There there will certainly be
Speaker 1: a time, I mean, I know this is this these days,
Speaker 1: it's a controversial topic, but there's certainly will be a
Speaker 1: day when equity markets are down more to drop a day,
Speaker 1: will you say there will be wait, do you say
Speaker 1: there will be a day? No, it's sorry a time
Speaker 1: I don't mean like a thing saying that this is
Speaker 1: going to be like or something that's that's more of
Speaker 1: a flash crash. But look, we at some points that
Speaker 1: you know there will be a recession in the US,
Speaker 1: there will global recession, and at some point you know,
Speaker 1: equity multiples will will contract. And this is and the
Speaker 1: the market is is very much set up to be
Speaker 1: a time bomb in exactly that in exactly that scenario
Speaker 1: sort of global equity markets down or more so, just
Speaker 1: to sort of wrap it all up, what people need
Speaker 1: to understand, I just sort of just to sort of
Speaker 1: summarize it is that essentially these notes, they're sold all
Speaker 1: over the world, but they're very heavily heavy in Korea
Speaker 1: and also in Japan. And the basic idea is the
Speaker 1: size of this market in these countries and the way
Speaker 1: that the issuers of these products have sort of migrated
Speaker 1: more and more of their hedging to the SMP creates
Speaker 1: a situation in which the activity of retail players in
Speaker 1: these countries can create some potentially extreme moves an SMP
Speaker 1: options and presumably the main index itself. As declines, we
Speaker 1: get declines and banks have to do all kinds of
Speaker 1: things to keep their exposures level. Yep, that's exactly correct. Ben.
Speaker 1: Thank you so much for for coming on. That's ben
Speaker 1: effort from QVR Advisors. Thank you for walking us through
Speaker 1: what is at times a complicated topic. You got a
Speaker 1: guy who was a lot of fun. Thanks Ben, that
Speaker 1: was great. I really appreciate it, so Joe, I really
Speaker 1: enjoyed that conversation. Um, I love talking and writing about
Speaker 1: structured products. It's half past midnight here in Hong Kong,
Speaker 1: and I weirdly don't feel tired at all because I'm
Speaker 1: so excited about talking about tarts and autocollables and all that.
Speaker 1: But one thing that definitely crops up in that conversation
Speaker 1: is just this notion that there's so much sort of
Speaker 1: self reflexivity built into financial markets nowadays. And you see it,
Speaker 1: you know, not just with these equity linked products, but
Speaker 1: you also see it with credit markets, where there's an
Speaker 1: argument over whether or not the derivatives indusseries can actually
Speaker 1: affect the cash bomb prices. You certainly see it in
Speaker 1: the volatility market with the vulpocalypse blow up of when
Speaker 1: these two tiny exchange traded products caused this big whiplash
Speaker 1: in the overall volatility market. It just feels like this
Speaker 1: is something that we're seeing time and time again. Absolutely,
Speaker 1: and obviously we should talk more about it. But I agree,
Speaker 1: it does feel like there is this, as you say,
Speaker 1: reflectivity in which these sort of like ongoing uh you know,
Speaker 1: ongoing attempts to hedge and to be balanced creates these
Speaker 1: extreme scenarios. Um, we should do another one before we forget,
Speaker 1: we should do another episode because they're bringing back one
Speaker 1: of those short vix et f s that blew up
Speaker 1: and big thing on. I saw that we should definitely
Speaker 1: do another one on this, but I thought, like Bend's explanation,
Speaker 1: it is extremely complicated and thinking about this sort of Um,
Speaker 1: the way the volatility or risk profile for the bank
Speaker 1: changes as the market goes from say, from flat to down,
Speaker 1: and then the volatility starts to collapse again as it
Speaker 1: gets to and then the knot can happens really hard
Speaker 1: to uh sort of wrap ones head around. But I
Speaker 1: thought Bend did a great job of a explaining that,
Speaker 1: but also why this is so hard for even the
Speaker 1: expert to price and why you see desks occasionally lose
Speaker 1: a bunch of money, right, And I guess the the
Speaker 1: corollary to that, you could say is that if it's
Speaker 1: that hard for the issuers to price the risk of
Speaker 1: selling these products, then should they really be going to
Speaker 1: retail investors in the first place. And I don't know
Speaker 1: if you've ever looked at the advertising for some of
Speaker 1: the equity links securities, but like it gets very creative
Speaker 1: and colorful. So I remember there was one that was
Speaker 1: sold in Korea that had like side from Gangnam style
Speaker 1: on it and made all these Gangnam neighborhood references. So
Speaker 1: I don't know, should retail investors really be diving into
Speaker 1: these things or or do the majority of them actually
Speaker 1: understand how they work. I mean, I was gonna we
Speaker 1: didn't get to it, but that was something that's been
Speaker 1: on my mind thinking about this is how could a
Speaker 1: retail investor, unless they're extremely sophisticated, have any idea whether
Speaker 1: they're getting a good value or not. Given how complicated
Speaker 1: the various payoff matrices are, especially when they include multiple
Speaker 1: index how would you ever know whether you're getting a
Speaker 1: good value? And Furthermore, I feel like if you were
Speaker 1: in a position to know, okay, this is actually a
Speaker 1: good product for me, you're probably sophisticated enough to trade
Speaker 1: options yourself and just create some sort of bespoke risk
Speaker 1: risk set up on your own. But that's kind of
Speaker 1: for a different discussion. Maybe yeah, or work on a
Speaker 1: Delta one desk, a large French bank or something. Right,
Speaker 1: all right, this has been another episode of the All
Speaker 1: Thoughts podcast. I'm Tracy Alloway. You can follow me on
Speaker 1: Twitter at Tracy Alloway and I'm Joe Why Isn't All?
Speaker 1: You can follow me on Twitter at the Stalwart, and
Speaker 1: you should follow for sure our guest Ben Effort. He's
Speaker 1: on Twitter. He's really awesome. His handle is Ben with
Speaker 1: two ends pe Effort. So definitely check out uself one
Speaker 1: of the great follows, and you should definitely follow our
Speaker 1: producer on Twitter. She's back in studio with us Laura Carlson.
Speaker 1: She's at Laura M. Carlson. And follow the Bloomberg head
Speaker 1: of podcast Francesco Leavie She's at Francesca Today, and follow
Speaker 1: all of Bloomberg's podcasts on Twitter at the handle at Podcasts.
Speaker 1: Thanks for listening,